Determinants of banks’ provisioning policies during the crisis

Abstract

Purpose – The purpose of this paper is to investigate the discretionary use of loan loss provisions in the Chinese banking sector during the global financial crisis. The objective of this paper is twofold: to add new evidence to the scant literature dealing with a peculiar banking sector, such as the Chinese one, and to shed more light on banks’ provisioning behaviour during stressed financial markets conditions. Design/methodology/approach – Using bank-level balance sheet and financial statements data, the authors test for income smoothing and capital management hypotheses, and detect differences in provisioning decisions of listed banks and unlisted financial intermediaries during turbulent financial markets conditions. Findings – The authors find support for the income smoothing hypothesis, but not for the capital management one. Chinese listed banks appear to be less risky and less involved in income smoothing to shift their risk, when compared to unlisted credit institutions. Social implications – The results obtained from this paper help to understand the functioning of bank provisioning regime in the Chinese banking system and how provisioning mechanisms can address the issues associated with the pro-cyclicality of bank capital requirements. Originality/value – Though referred to a particular banking sector, such as the Chinese one, the results of this paper can provide a tremendous incentive to those national and international authorities that are bound to promote forward-looking provisioning practices. These practices would allow banks to build a buffer of reserves to face the downward pressure on earnings and capital associated with periods of worsening credit quality.